“Sell in May and walk away” is the catch phrase of the weak season for equities we have just embarked upon. According to the linked article, returns since 1950 during the May-October period have been .3% annualized, while the remaining 6 months have averaged 7%. The largest market crashes, including the 15%+ selloffs of the QE era (2010 and 2011) have all occurred during this season. With the S&P at all-time highs, sentiment starting to pull back from prolonged elevated levels, the Fed reducing stimulus, and various potential sources for geopolitical conflagaration, it is difficult to argue against this being another rocky season.
GMO identifies other reasons for concern in their excellent quarterly letter. In particular two indicators point to a difficult year for stocks: 1) it’s the second year of the presidential term, typically the worst of the four, and 2) January was negative, and “as January goes…” They acknowledge that these rules are awfully arbitrary, but for whatever reason, they have worked. They do go on to contend that stocks will recover from seasonal weakness and move on to bubble valuations, but at least through the later part of the year expect trouble.
So if stocks are likely on most counts to experience a stumble, if not an outright fall this year, what are we to do about it? US stocks are in a long-term uptrend, so we would not dream of shorting them. Gradually reducing exposure, as GMO is doing, is likely prudent if your equity weighting is substantial and/or you require the funds within a 7-year time horizon. For my purposes, the equity weighting in the investment account is already fairly light and my horizon is long, so I am closer to accumulation mode on price weakness. It would take a move to aforementioned bubble valuations (2300 or so in the S&P) to bring me to reduce exposure materially.
A QE end prediction
SPY, the S&P500 ETF, source Barchart Trader (www.barchart.com)
For my part, the most likely timing for a major market decline is at or around the end of the current round of quantitative easing. The Fed has never actually allowed QE to end before, but every time they have started to do so, stocks have swooned 15-20%. And then they only rebounded on the promise of fresh stimulus. The question for later this year is, has the Fed provided the market with enough speculative fodder to reach “escape velocity”, as it had in 2003? The best I can guess is, maybe. But before we find out, a 15% decline is likely in the cards. If the market continues to rally or even remain around current levels into the October QE end date, I would increasingly look at shorting the market from a trading perspective.
Japan saves the day
Japan offers some interesting opportunities currently. Though Prime Minister Abe’s actions have stimulated a temporary turnaround in Japan’s currency and stock markets, closer inspection reveals that these, though large, are likely to be transient. As you can see, both the USD/JPY and the Nikkei are in long-term downtrends. Against that, the recent cyclical counter-trend movements have resulted in significant price rebounds and, at well over two years in duration, are becoming mature. We have in place the criteria for investing outlined in the last update – value and time. Accumulating short positions in the Nikkei or long positions in JPY has investment merit. In general, I prefer to be long only in the investment account – though long put options on the Nikkei could be an interesting trading play for the next few months or as an alternative to shorting US stocks into the end of QE. So out of these market opportunities, I like accumulating some yen here. Investment: buy yen at 102 with 5% of portfolio; continue buying at 110 and 120. As always, the trend could change, but I think the current euphoria around Abenomics will eventually come back to earth, giving us an opportunity for attractive gains.
GLD and TLT daily charts, source Barchart Trader (www.barchart.com)
In other markets of interest, bearish forces have regained control of gold, helping us to avoid that scary head and shoulders bottom, at least for now. Bonds have been very strong in the face of rising equities and an imminent end to QE. This (as well as stock market strength) is likely due in large part to expectations that the ECB will embark on a QE program of its own. Bonds remain in a cyclical bear market and sentiment is approaching bullish extremes reached in May 2013 at much higher prices, so this is a trading opportunity in bonds. Trade: sell TLT short at 114 with 5% of the trading account, and add on a further rally and increase in sentiment; stop out on a weekly close above 125, and take profit at new lows. As with stocks, the next major move in bonds is likely to occur with the end of QE, and if history is any guide it will be a rally. I am positioned for such in the investment account and would look to add trading exposure if bonds trade lower into the QE end date.
30% USD cash
25% US fixed income
25% US equities
YTD return: 5%
5% short GLD
5% short TLT
YTD return: 0%
- Video – Tokyo Sakura
- The Blue Belt Diet